LONDON (Reuters) -One of Britain's leading business groups on Wednesday slashed its forecast for economic growth in 2025 and next year due to headwinds from U.S. President Donald Trump's tariffs and an increase in payroll taxes, a survey showed.

Growth this year is now forecast to be 1.2%, the Confederation of British Industry said, lower than the 1.6% it predicted in December. The economy will then expand by 1.0% in 2026, down from its previous forecast of 1.5%.

It said labour cost increases – such as the rise in social security contributions and the minimum wage that came into effect in April - were affecting firms' hiring and investment plans, and are also expected to push up prices and reduce profits.

The forecasts were made before the conflict between Israel and Iran broke out last week and pushed up oil prices. The CBI said that it was monitoring any impact on UK households, businesses, and inflation.

"The unpredictable global outlook combined with rising employment costs, gloomy business sentiment, and subdued investment intentions means it's more important than ever that government pulls all the levers it can to set the UK on a path to sustainable growth," Louise Hellem, chief economist at the CBI, said.

The CBI's forecast assumes the direct impact on the UK from tariffs will be limited as goods exports to the United States account for around 7% of total UK exports, although they will likely weigh on business activity.

Britain's economy contracted sharply in April due to a one-off hit from the end of a tax break on property sales and concerns about Trump's announcement of wide-ranging tariffs on April 2. 

So far, it is the only major economy to have agreed a trade deal with the U.S., which is intended to exempt Britain from Trump's increased tariffs on aluminium and steel imports, although a 10% goods levy remains in place.

The Bank of England at its last interest rates decision in May estimated that Trump's tariffs will lop 0.3% off annual output in three years' time, and slightly push down on inflation.

The BoE is expected to keep rates on hold next week, and investors are pricing in two more quarter-point rate cuts by the end of 2025.

The CBI expects inflation to remain above the BoE's target this year, partly due to higher household energy costs and regulated water bills, before falling to 2.5% in 2026.

Wage growth was set to weaken and the BoE will cut its benchmark Bank Rate slowly to 3.5% by late 2025 from 4.25% now, the CBI said.

Economic growth in 2026 will be largely driven by household spending, the CBI said, with cooling inflation and lower borrowing costs to help consumer spending pick up.

But economists at the CBI were not expecting measures announced in finance minister Rachel Reeves' Spending Review last week to have much of an impact on growth in 2025 and 2026, although they saw a benefit in the long term.

"The Spending Review signalled a down payment on hardwiring the growth mission into government priorities, with targeted investment that will raise the long-term ceiling of the economy," Hellem said.

(Reporting by Suban Abdulla, editing by Andy Bruce)